The Case for Dollarization in Argentina: A Path to Economic Stability

Post originally published on EconLib.

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Argentina, a nation that epitomizes inflationary finance, finds itself once again at a crucial juncture. The recent shift in leadership, marked by economist and self-described libertarian Javier Milei’s unequivocal statement that closing the central bank is non-negotiable, has reignited debates about the prospect of dollarizing the Argentine economy. Milei has initiated a tough austerity plan, to be succeeded by substantial deregulation. If these reforms are forthcoming, why dollarize? Here are three reasons.

Dollarization as a Credible Commitment Device:

The primary rationale lies in the necessity for a credible commitment device. This paper by Emilio Ocampo explains how dollarization can serve as such for Argentina. Drawing from the experience of Ecuador under Rafael Correa, we see that dollarization acts as a credible institutional constraint that diminishes the costs associated with a populist regime. In a country where political shifts are frequent, and the probability of populism returning to power is 100%, establishing a stable monetary system becomes indispensable for sustained economic success.

Dollarization is Cost-Effective and a Safer Solution:

In relative terms, dollarization is the most cost-effective and safest alternative. With an annual inflation rate hovering around 160% (and expected to go up in the coming weeks), the demand for Argentine pesos is practically nonexistent. Dollarization facilitates the redenomination of financial liabilities in pesos into US dollars, eliminating the risk of a run against the peso. This would not only stabilize the currency but also afford the government more time to enact necessary changes. Given the combination of high inflation and a lack of credibility in Argentine politics, the amount of US dollars required to sustain the peso exceeds the US dollars needed to implement dollarization. Those who argue that dollarization is not possible due to the lack of dollars at the central bank need to think seriously about where they intend to obtain the dollars to bring the peso back to life. Furthermore, as dollarization implies phasing out the peso, its success becomes more plausible than reviving the peso.

Dollarization facilitates Addressing a Large Monetary Disequilibrium:

The third rationale stems from the magnitude of the monetary disequilibrium confronting Argentina. The central bank’s issuance of short-term liquidity bills (Leliq) and other financial liabilities, reaching three to four times the base money, has placed the nation on the precipice of hyperinflation. Any policy aiming to sustain the peso must generate a confidence shock substantial enough for peso demand to absorb the outstanding amount of these financial liabilities in a timely manner. Can Milei, with no governors and only a handful of representatives in Congress, garner enough support to generate such a shock? Dollarization also allows more time to grapple with the “liquidity bills problem.” Not only would dollarization stabilize the economy, but it would also lay the foundation for constructing a robust and sustainable financial system.

Argentina’s persistent struggle with inflation, which has averaged 60% annually since the mid-1940s, has impeded long-term planning and economic growth. The nation has exhausted every textbook solution to high inflation, all of which have proven futile. The most successful attempt was the 1990s convertibility law, which, due to poor political decisions, culminated in an economic crisis of historic proportions and eroding the credibility of this monetary regime. Dollarization presents a credible means to break free from the cycle of high inflation and severe future crises by cutting the ties between domestic politics and the monetary regime in place, offering a more stable environment for economic planning and growth. When the political system is fiscally irresponsible and central bank independence is a chimera, price stability can only be achieved by adopting a stable currency as legal tender. That is the case of Argentina today.